The effective exchange rate is an index that reflects the relative price of the shekel vis-à-vis a basket of currencies, with the weight of each currency reflecting that currency’s importance in Israel’s foreign trade.  Israel maintains economic ties with many other countries.  As a result, a large number of exchange rates affect competitiveness and prices in Israel.  The effective exchange rate index assists in tracking the level of competitiveness in the economy and the functioning of the foreign exchange market, helps in measuring the “pressure” on domestic prices as a result of a change in the exchange rates, and constitutes an important input in the Bank of Israel’s policy decisions.
This document re-examines the weights of the currencies in calculating the effective exchange rate.  The Bank of Israel calculates and publishes an effective exchange rate index on a daily basis.  The original index was revised at the beginning of 2009, using data from 2006–7.  Since then, there has been a shift in trade that is reflected in an increase in the share of trade of goods with developing economies, especially in the share of China.  The revision here is based on 2013 data for the trade of goods, and 2012 data for the trade of services.
The revised weights are also based on exports and imports of business services. These services were previously considered nontradable by definition, and the weight of these services in foreign trade has increased consistently, so that they now constitute about one-quarter of total exports.  Expanded coverage of Central Bureau of Statistics data, which now also include the geographic distribution of trade in services (source and destination), makes it possible for the first time to use them in calculating the weights in the index.  The data show that the US is the source and destination of about one-half of trade in business services.
The revised basket includes a lower number of countries.  The new basket includes 33 countries and 26 currencies, instead of the 38 countries and 28 currencies included until now.  Foreign trade has become more concentrated:  Nine countries have been removed from the basket, after trade with them fell below 0.5 percent. and four countries were added to the basket. The weight of the US dollar in the new basket is greater, and the weight of the euro is lower than in the current basket. In addition, China’s weight increased. The strengthening of the dollar relative to the euro in the past year leads the new index to indicate a slightly depreciated (i.e. higher) exchange rate environment than what was derived from the existing index.  However, the index remains the most appreciated in a long time.
This document includes: 1. Background information; 2. A description of the trends in Israel’s foreign trade; 3. A revision of the weights in the effective exchange rate; 4. A comparison of the new exchange rate with the old and ramifications for the current level of the exchange rate.

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